Legislation would give Treasury broader powers to dissolve insolvent companies that pose systemic risk
The Obama Administration on Mar. 25 issued details on proposed legislation for a "resolution authority" that would give the President sweeping powers to dismantle or reorganize failing companies that pose a threat to the country's financial system. The proposal would also effectively shift some authority now held by the judiciary to the executive branch in an effort to speed up what could otherwise be slow-moving bankruptcy proceedings.
The goal of the proposal is to give the government better tools to handle the failure of giant and deeply intertwined financial firms like insurance behemoth American International Group (AIG) and banking titan Citigroup (C)—companies that have absorbed billions of dollars in federal aid because officials worried their collapse could bring down other large companies, and much of the economy with it.
Indeed, supporters of the proposed resolution authority point to the demise of Lehman Brothers, the big investment bank whose bankruptcy filing last fall left its business partners and investors scrambling and helped precipitate the financial crisis that continues today. The Bush Administration and Federal Reserve took heated criticism for failing to prevent Lehman's collapse, but officials at the time, as well as some in the Obama Administration, have argued they lacked the legal authority they needed to do otherwise.
"One of the key lessons of the current crisis is that destabilizing dangers can come from financial institutions besides banks, but our current regulatory system provides few ways to deal with these risks," Treasury Secretary Timothy Geithner said in prepared remarks delivered to the Council on Foreign Relations in New York on Mar. 25.
Specifically, the proposed legislation would apply to "financial institutions that have the potential to pose systemic risks to our economy" but which aren't subject to the Federal Deposit Insurance Corp.'s power to shut down banks, according to a fact sheet issued by the Treasury Dept. That power doesn't extend to bank holding companies, or insurance holding companies like AIG, where much of the economic risk resides.
The measure would require the Treasury Secretary to act with the Federal Reserve Board and the failing company's federal regulatory agency, as well as in consultation with the President. Together, they would have to conclude that the company is at risk of insolvency, and that invoking the proposed law's authorities would prevent or reduce harm to the economy or the stability of the U.S. financial system. Ultimately, the Treasury and FDIC would make the decision to apply the new authority to a given company.
The government could reorganize the company, replacing its executives and directors, and make loans to the company, buy its debts or assets, or buy a stake in the institution—powers the Treasury said are similar to current law governing the resolution of failed banks.
Although the details of funding such actions weren't spelled out in the Treasury's announcement, the department said it could include using general revenue funds or assessing other financial institutions covered by the legislation. The government could also recoup costs through repayment of its loans to the institution, or subsequent sale of the government's equity stake.
In making its case, the Treasury says the move would "reduce the need for taxpayer funds" by allowing the government to sell or transfer debts and assets of the failing companies directly—and to renegotiate contracts. Contractually guaranteed bonuses to some employees of a controversial unit of AIG helped provoke a firestorm of criticism last week, and some political analysts say the Administration's move to push resolution authority ahead of its other financial reforms reflects the need to respond to public outrage over the bonuses.
"Had the government possessed the authorities contained in the proposed legislation, it could have resolved AIG in an orderly manner that shared losses among equity and debt holders in a way that maintained confidence in the institutions' ability to fulfill its obligations to insurance policyholders and other systemically important customers," the Treasury said in announcing its proposal.
The federal government has a process in place to resolve failing companies, of course: bankruptcy court. But critics say it is too slow, potentially dragging out the kind of orderly resolution officials would like for dying financial corporations, which in turn would leave the financial institutions they did business with at continued risk for failure themselves. Moreover, critics argue that bankruptcy court is geared toward resolving claims by creditors, without considering the broader economic effects of a company's liquidation or reorganization—critical factors, they say, with institutions woven as deeply into the country's financial fabric as AIG proved to be.